Unintended consequences of well-intended regulation : the procyclical effects of the Basel I capital regulations on the U.S. banking industry.
Numerous solutions have been posed to address the risks that fractional reserve banking systems cause for depositors. The newest regulatory trend to combat these issues has been capital regulation. Many critics have accused capital regulation of increasing the natural procyclicality of bank loan supply. However, to date the literature appears to say little on whether or not the Basel I capital regulations have any effect on the natural procyclicality of bank loan supply. To test this, I constructed a new loan supply function to determine the relationship between the business cycle and the real loan supply. A Chow Test was then conducted to determine whether this relationship changed at the date of Basel I implementation. I found that this relationship increased significantly after the implementation of Basel I, allowing me to conclude that the Basel I capital regulations increased the natural procyclicality of bank loan supply.